What are we looking for?
A screen for U.S. dividend stocks that are cheap yet have strong earnings growth.
More about today's screen
On Tuesdays we do a screen with Morningstar CPMS. We'll use PEG ratios again for the third week in a row. PEG stands for price/earnings to growth and is a ratio that helps investors figure out whether they're overpaying for a stock's earnings growth.
Today's exercise will use PEG ratios for U.S. dividend stocks, imitating the screen we did for Canadian dividend stocks last week.
First, more background. PEG is calculated by taking the P/E and dividing it by earnings growth. For instance, if a company's P/E is 10 and its earnings growth is 10 per cent, then its PEG would be 1. If the P/E were just five on earnings growth of 10 per cent, then the PEG would be 0.5. If the P/E were 20 on growth of 10 per cent then the PEG would be 2. Lower PEGs are better if you want to buy cheap growth.
To add dividends to the screen, we're going to calculate the PEGY ratio (the Y in PEGY stands for yield and you can give this ratio a nickname by pronouncing it the way it sounds). The ratio is calculated by taking the P/E and dividing it by the sum of five-year normalized earnings growth and expected dividend yield. CPMS uses five-year earnings growth normalized to remove unusual accounting items.
Jamie Hynes, senior consultant at Morningstar CPMS, also added the following criteria to the screen: Stocks are selected from the S&P 500 and limited to five per sector and a dividend yield greater than 1 per cent.
About CPMS
Morningstar CPMS, a Toronto-based equity research and portfolio analysis firm, maintains a database of about 660 of the largest and more liquid Canadian stocks, plus another 2,100 U.S. stocks, and spends a lot of time adjusting for unusual accounting items in each company's quarterly results to make sure screens can perform correctly.
What did we find out?
By reselecting the top 20 names every year, this screen has outperformed the S&P 500 total return index by 5 per cent annualized (12.7 per cent versus 7.7 per cent) since Dec. 31, 1993, when CPMS started collecting U.S. data, Mr. Hynes said.
Over the past year, the strategy has produced results almost double the S&P 500 total return index, returning 30.1 per cent versus 16.5 per cent for the index. On the downside, this strategy lost 63 per cent from October, 2007, to February, 2009, versus a 51-per-cent loss by the S&P 500 over the same period.
"The key strength of a quantitative model is discipline, but this would have been tough to swallow for the most disciplined investors," Mr. Hynes said.